The controller of the Ijiri Company wants you to estimate a cost function from the following
two observations in a general ledger account called Maintenance:

Month Miles Driven Delivery Costs

January 6,000 $4,000
Februar 10,000 5,400
y

Required:
1. Estimate the cost function for maintenance.
2. Can the constant in the cost function be used as an estimate of fixed maintenance cost per
month? Explain.

SOLUTION

(10 min.) Estimating a cost function.

1. Slope coefficient = 
= $5,400-$4,00010,000-6,000
= $1,4004,000 =   $0.35 per machine-hour
Constant = Total cost – (Slope coefficient × Quantity of cost driver)
= $5,400 – ($0.35×10,000) = $1,900
= $4,000 – ($0.35×6,000) = $1,900

The cost function based on the two observations is

Maintenance costs = $1,900 + $0.35× Machine-hours

2. The cost function in requirement 1 is an estimate of how costs behave within the relevant
range, not at cost levels outside the relevant range. If there are no months with zero machine-
hours represented in the maintenance account, data in that account cannot be used to estimate the
fixed costs at the zero machine-hours level. Rather, the constant component of the cost function
provides the best available starting point for a straight line that approximates how a cost behaves
within the relevant range.

10-22 Identifying variable-, fixed-, and mixed-cost functions. The Bengal Corporation
operates car rental agencies at more than 20 airports across India. Customers can choose from
one of three contracts for car rentals of one day or less:

◼ Contract 1: $50 for the day

◼ Contract 2: $30 for the day plus $0.20 per mile traveled
◼ Contract 3: $1 per mile traveled

Required:
1. Plot separate graphs for each of the three contracts, with costs on the vertical axis and miles
traveled on the horizontal axis.
2. Express each contract as a linear cost function of the form y = a + bX.
3. Identify each contract as a variable-, fixed-, or mixed-cost function.

SOLUTION

(15 min.) Identifying variable-, fixed-, and mixed-cost functions.

1. See Solution Exhibit 10-22.

2. Contract 1:  y = $50

Contract 2:  y = $30 + $0.20X
Contract 3:  y = $1X

where X is the number of miles traveled in the day.

3. Contract Cost Function

1   Fixed
2  Mixed
3 Variable

SOLUTION EXHIBIT 10-22

Plots of Car Rental Contracts Offered by The Bengal Corp.